A Debenture secures a loan using the borrower’s assets and all terms conditions and warranties are recorded in a Debenture Agreement. If the bank decides to withdraw, reduce or demand payment of the debenture and the company is unable to meet the payment, then the bank will look for the Guarantor to pay up.
Problems often arise when the company goes into liquidation and the bank attempts to recover its loan from the liquidation process. Creditors are paid in order of priority and charges over fixed assets are paid first. There is often little left for those who have a floating charge. It is therefore in the banks best interest to see if there was a fixed charge on the book debts so that they have priority as a creditor during the liquidation procedure.
However, it can be difficult to determine whether a bank has a fixed or floating charge, and the issue has been referred to the Courts to decide on many occasions.
The view of the Courts has changed over the years.
In the case Siebe Gorman & Co Ltd v Barclays Bank Ltd  2 Lloyd’s Rep 142, it was upheld that a declaration in a Guarantee can create a fixed charge over book debts for a debenture.
In the Brumark Investments case (Agnew v Inland Revenue Commissioner  2 AC 710), it was held that it is not possible to have a fixed charge over book debts. However, this case did not involve the standard form of debenture used by many clearing banks following the Siebe Gorman case above.
It was not until the Spectrum case (in 2004), that the court held that the Siebe Gorman case was wrongly decided. The court held that there is a two-stage process to determine whether a charge is fixed or floating:
- Ascertain from the instrument of charge the nature of the rights and obligations intended between the parties in relation to the assets. Consideration should be given to any express restrictions on the use of the account with the bank. Where the bank reserves the right to withdraw, reduce or demand payment of the debenture, but the Company is free to draw cheques in favour of suppliers or creditors in the ordinary course of business, then this would be construed as a floating charge.
- Categorise those rights and obligations as a matter of law. If the book debts were to be under the control of and available for use by the Company in the ordinary course of business then this is a badge of a floating charge.
The decision of the High Court in the Spectrum case was appealed and the House of Lords decided to uphold the decision.
The terms of the Debenture Agreement should therefore be scrutinised and the two-stage process outlined above by the Spectrum case should be applied to determine whether the bank has a fixed or floating charge over the book debts.
Consideration should also be given to the information supplied by the bank in relation to the Debenture and what advice or disclaimers were given at the time of signing?